Bank CP Rate Gap to Bills at Lowest Since August: Credit Markets

Bonds of Anheuser-Busch InBev NV were the most actively traded dollar-denominated corporate securities by dealers last week, with 614 trades of $1 million or more, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. Photographer: Ken James/Bloomberg

July 16 (Bloomberg) -- Short-term borrowing costs for
financial institutions have fallen to the lowest since August
relative to U.S. Treasury bills in a sign of growing investor
confidence that banks will weather Europe’s escalating debt
crisis and the slowing economy.

The difference between what U.S. financial institutions and
the government pay to borrow for three months has narrowed by
almost 50 percent since December to 32 basis points. The gap
between the commercial paper and Treasury bill rates has shrunk
from a 2 1/2-year high of 58 basis points on Dec. 8. A separate
measure of debt-market stress, the two-year interest-rate swap
spread, is near an 11-month low.

Money managers are accepting lower rates to lend money to
U.S. financial institutions even after they were among 15 global
lenders downgraded by Moody’s Investors Service on June 21.
Dollar-denominated bonds from banks are returning more than
twice as much as stocks this year as lenders boost capital to
meet new risk-curbing regulations.

“From a banking sector standpoint the U.S. is much further
along than the European banking sector,” said Dan Greenhaus,
the chief global strategist at broker-dealer BTIG LLC in New
York. “This is what the Federal Reserve wants of course, for
yields to come down everywhere. For the Fed, anytime you see the
narrowing of the spread of a risk-asset to a safer asset, all
else equal, they have to be encouraged.”

The cost of protecting U.S. bank bonds from default is at
the lowest relative to European lenders ever in records going
back to 2005, according to data compiled by Bloomberg.

Rate Swaps

The U.S. two-year interest-rate swap spread shrank to 23
basis points at the end of last week, from 59.25 basis points on
Nov. 22, an 18-month high. The spread increased 1.1 basis points
today to 24.13.

The gap between two-year swap rates and comparable maturity
Treasury note yields has averaged 48 basis points since January
2007. The swap spread is based in part on expectations for the
dollar-denominated London interbank offered rate and is used as
one measure of investor perceptions of bank credit risk.

Elsewhere in credit markets, the extra yield investors
demand to hold corporate bonds globally rather than government
debt fell for a sixth week, reaching the lowest in almost two
months. Offerings worldwide soared as the cost of protecting the
debt from default in the U.S. fell. In emerging markets, spreads
narrowed to the least in two months.

Spreads Narrow

Relative yields on company bonds from the U.S. to Europe
and Asia narrowed two basis points to 212 basis points, or 2.12
percentage points, the lowest since May 15, according to Bank of
America Merrill Lynch’s Global Broad Market Corporate index.
Spreads have declined from 236 on June 1, the highest since
January. Yields fell to 3.124 percent from 3.194 percent July 6.

The Barclays Global Aggregate Corporate Index has returned
0.64 percent this month, bringing returns for the year to 4.84
percent.

Bonds of Anheuser-Busch InBev NV were the most actively
traded dollar-denominated corporate securities by dealers last
week, with 614 trades of $1 million or more, according to Trace,
the bond-price reporting system of the Financial Industry
Regulatory Authority.

A $7.5 billion offering from the maker of Budweiser and
Stella Artois led $75.4 billion of corporate bond sales
worldwide last week, a 42 percent increase from $52.9 billion in
the week ended July 6, Bloomberg data show. Weekly sales have
averaged $74 billion this year. Anheuser-Busch’s $3 billion of
2.5 percent, 10-year notes rose 1.3 cents from the issue price
on July 11 to 100.8 cents on the dollar to yield 2.4 percent,
Trace data show.

Leveraged Loans

The Standard & Poor’s/LSTA U.S. Leveraged Loan 100 Index
rose 0.54 cent last week to 94.09 cents on the dollar, the
highest since May 16. The measure, which tracks the 100 largest
dollar-denominated first-lien leveraged loans, has climbed from
91.8 on June 5, the lowest since Jan. 6.

Leveraged loans and high-yield bonds are graded below Baa3
by Moody’s and lower than BBB- at S&P.

In emerging markets, relative yields narrowed 12 basis
points to 357.9 basis points, the least since May 10, according
to JPMorgan Chase & Co.’s EMBI Global index. The benchmark has
tightened from this year’s high of 440.9 on Jan. 13.

The Markit CDX North America Investment-Grade index, which
investors use to hedge against losses or to speculate on
creditworthiness, decreased 0.8 basis point to a mid-price of
111.9 basis points, according to prices compiled by Bloomberg.

Bail-In Bets

The cost of insuring against default on European senior
bank bonds rose after the region’s central bank was said to drop
its opposition to holders of the securities taking losses in
bailouts.

The Markit iTraxx Senior Financial Index of credit-default
swaps on 25 banks and insurers climbed seven basis points to 280
as of 12:21 p.m. in London, the highest in a week. The European
Central Bank supported imposing losses on senior bondholders of
ailing Spanish banks at a Brussels finance ministers meeting on
July 9, though the proposal didn’t get much traction, said an
official with knowledge of the matter, who asked not to be
identified because the talks were private.

Credit-default swaps typically fall as investor confidence
improves and rise as it deteriorates. Contracts pay the buyer
face value if a borrower fails to meet its obligations, less the
value of the defaulted debt. A basis point equals $1,000
annually on a contract protecting $10 million of debt.

IMF Forecast

The International Monetary Fund will cut its 3.5 percent
estimate for global growth this year, Managing Director
Christine Lagarde said. The “key emerging markets” of Brazil,
China and India are showing signs of slowdown and the IMF’s
growth outlook “has regrettably become more worrisome,”
Lagarde said July 6 in Tokyo.

“Financial conditions look like they are relatively stable
and growth supportive in the U.S.,” Michael Darda, chief market
strategist at MKM Partners LP in Stamford, Connecticut, said in
a telephone interview. “That’s a silver lining because the
recent economic data flow has been weak. The credit markets and
other indicators tend to give us a forward look on what might
happen to the business cycle.”

The Fed’s Federal Open Market Committee, which has kept its
benchmark interest rate near zero since December 2008,
reiterated last month that it expects to keep rates
“exceptionally low” at least through late 2014.

The Fed under Chairman Ben S. Bernanke bought $2.3 trillion
of Treasury and mortgage-related debt to stimulate the economy.
It decided in June to extend a policy known as Operation Twist,
in which it sells short-term securities and uses the proceeds to
buy longer-term debt, through December by an additional $267
billion.

Treasury Bills

Selling commercial paper is one way that banks can obtain
short-term loans. The instruments are issued at a premium to
Treasury bills, which are viewed as riskless because they’re
backed by the full faith and credit of the U.S. government. In
the 10 years prior to 2007, when the subprime mortgage market
collapsed and triggered a global financial crisis, three-month
commercial paper rates averaged 30.5 basis points more than
Treasury bills, Bloomberg data show.

“At this time, commercial paper is not as good an economic
indicator as it would be under more normal interest rate
circumstances,” Leonard Santow, managing director at economic
and financial consulting firm Griggs & Santow Inc., said in a
telephone interview. “When you get close to zero on Treasuries,
it creates distortions.”

Relative Yields

Rates on three-month, non-asset backed commercial paper
were 0.41 percent last week, according to an index of A1/P1/F1-rated programs compiled by Bloomberg that consists of a majority
of financial firms. While three-month Treasury bills traded at
0.09 percent and three-month dollar Libor was 0.4551 percent.

“The fact that commercial paper rates have come in
relative to Treasury bill yields, which have barely moved from
near-zero levels all year, signals that investors are now
happier to lend to U.S. corporations,” said Moorad Choudhry,
treasurer at Royal Bank of Scotland Plc’s Corporate Banking
Division in London.

While U.S. investment-grade corporate bond yields fell to a
record 3.18 percent on July 13, spreads are wider than before
the credit crisis, according to Bank of America Merrill Lynch
data. Dollar-denominated bank bonds have returned 8.5 percent
this year, according to Bank of America Merrill Lynch data,
compared with 4 percent for bank stocks.

‘Demand for Yield’

“With three month Treasury bills rates so low, unless you
are really forced to invest in them, few want to purchase
them,” said Jim Lee, head of short-term markets and futures and
options strategy in Stamford, Connecticut, at Royal Bank of
Scotland Group Plc’s RBS Securities Inc. “There is demand by
investors for yield in this lower for longer Fed rate
environment.”

The commercial paper market has declined since the failure
of Lehman Brothers Holdings Inc. ignited a financial crisis,
with the total amount outstanding falling to $982 billion from
more than $2.2 trillion in July 2007. Joseph D’Angelo, head of
money market fixed income at Prudential Financial, who oversees
about $50 billion in assets, said it may never regain the same
levels, with regulatory concerns affecting both companies
supplying new issues and funds investing in the securities.

“When Lehman collapsed, that effectively brought all kinds
of scrutiny to the money market fund industry,” D’Angelo said.
“For companies, plenty of issuance was related to long-term
leverage financed by short-term liabilities and obviously that
whole model was not acceptable anymore.”

Ratings Cut

In the Moody’s downgrades of global banks, Citigroup Inc.
and Morgan Stanley were pushed out from the top-tier of
investment-grade, with their respective ratings cut to Baa2 from
A3 and Baa1 from A2.

New regulations from U.S. Congress and the Basel Committee
on Banking Supervision are spurring the biggest banks to pare
holdings of corporate bonds to $42.3 billion as of July 4 from a
peak of $235 billion in October 2007, according to Fed data. The
face value of bank bonds in a Bank of America Merrill Lynch
index has fallen to $905.3 billion from a peak of $947.2 billion
in July 2011.

The top U.S. prime money-market mutual funds allocation of
assets invested in euro-zone banks slid 67 percent in the 12
months through May, according to a Fitch Ratings report on June
22. As money funds have cut investment in euro-zone banks
they’ve increased allocation to U.S. government securities and
repurchase agreements, a form of collateralized lending, Fitch
wrote in a separate note published on July 12.

Credit-default swaps on 13 European banks such as BNP
Paribas SA and UBS AG have diverged from those tied to the six
largest U.S. banks, with the gap at 67.3 basis points on July
13. In February, there was no gap in the average price of the
contracts.

‘Recovery Cycle’

“I would personally rather give money to U.S. banks as
BBBs than give the money to single-A rated companies in
Europe,” D’Angelo said. “If you are going to lend money to
financial institutions in the current environment, you feel most
comfortable lending to U.S.A.”

U.S. money funds reduced their euro-zone debt holdings by
the most in 2012 last month, cutting their exposure by $73.5
billion to $286 billion in June, according to data compiled by
Westborough, Massachusetts-based research firm IMoneyNet Inc.

The European Central bank’s cut in its benchmark rate to a
record low led JPMorgan, Goldman Sachs Group Inc. and BlackRock
Inc. to close money market funds to new investments.

“The further we move along in this recovery cycle -- long,
slow and painful though it may be -- we are starting to see some
signs of generally healthier balance sheets in the corporate
sector,” said Jeffrey Caughron, a partner at Baker Group LP in
Oklahoma City who advises community banks on investments of more
than $30 billion. “There is also the realization that we are
going to be at very low levels of interest rates generally
longer than people had previously thought.”